Rural Finance Practitioner
There has been a lot said about the role of the Andhra Government by many experts, especially from the international micro-finance and the larger development field. While their view points are appreciated, I would also like to set the record straight as a neutral observer...as some one who has closely followed the Krishna crisis as well as the present Andhra Pradesh micro-finance crisis…We need to set the record straight because some crucial lessons exist for all stakeholders and they have, thus far, been ignored…
At the outset, let me clarify that I am not in favour of the ordinance and/or bill that were promulgated/passed by the Andhra Pradesh government as I feel that micro-finance is micro-banking and its regulation (framing of rules) and supervision (ensuring adherence to these rules) should come under the purview of the Government of India and especially, The Reserve Bank of India. I have already strongly put forth this view in my previous posts. The fact that the NBFC MFI model is the dominant one in Indian micro-finance as of today, lends considerable credence to the above argument...and I hope that all policy stakeholders recognise the above basic fact.
Let me now state things, as I have seen them unfold over the last few years...backed by relevant data where available…
The Precursor – The NABARD High Level Policy Conference: Much of the problems evident in the 2005/6 Krishna crisis were articulated by Dr Thorat (Then Managing Director, NABARD) and this writer, in a paper, presented at the NABARD High Level Policy Conference in New Delhi in May 2005. A Senior Joint Secretary, Ministry of Finance chaired the panel that discussed the above paper, and the discussions (with people at the plenary) were rather animated, as the paper and its presentation appeared to have ruffled a few feathers. That the paper provoked a lot of people, especially the proponents of the MFI model, was evident from the fact that the presenters for the next session, devoted to products and innovations, focussed almost entirely on issues raised in the above paper – rather than making their own presentations.
Senior MF industry stalwarts said (on record) that MFIs have good systems and governance and are not engaging in any kind of bad practices. I left the conference with an uneasy feeling – that somehow, the issues mentioned in the paper were going to prove critical to the survival of the micro-finance industry and yet, the micro-finance industry was dismissing the issues raised as either mere aberrations – whereas I knew for a fact that the malaise was indeed spreading fast like cancer…
So, when the Krishna crisis suddenly came up, I was not at all surpised…
The Krishna Crisis: The Krishna crisis of 2005/2006 was preceded by large-scale growth (large scale for the context that existed then). The Krishna crisis effectively started in March 2005, when the late Dr Rajasekhar Reddy, then Chief Minister of Andhra Pradesh, visited Guntur/Krishna Districts in the last week of march 2005 (I recall the date as March 29th, 2005) and asked the then collector, Mr Naveen Mittal (IAS) to enquire into the allegations against some MFIs, made by the then sitting MLA Mr Venkat Rao and others. A huge consequence of the Krishna crisis was that the partnership model of ICICI was done away with…and at least 50 branches of some MFIs were closed…to be reopened later…after assurances by the MFIs and key stakeholders…
Much of the why the Krishna crisis happened has been articulated in the earlier companion post…and I will not get into it here…but one point needs emphasis here… The micro-finance industry came together and promised several things to the Andhra Pradesh government…to cool the heat…
Commenting on the causes of the Krishna crisis, Mr Prabhu Ghate, in the State of the Sector Report notes, “One of the longer term causes was clearly the "quest for numbers" relating to outreach and profitability that is the main motivation of many MFIs. While extending the depth and breadth of outreach is clearly central to microfinance's mission of making an impact on poverty through financial inclusion, and while sustainability is essential if MFIs are to attract lenders and investors in order to grow, the crisis serves as a useful reminder that there are other just as important client-centred consumer protection objectives such as transparency in dealings with borrowers and being careful not to saddle them with more debt than they can handle. These are goals that apply equally to minimalist as well as more holistic microfinance. We are all responsible for building up a climate of expectations (including perhaps the preceding chapter!) that celebrates the interrelated achievements of rate of growth of outreach, efficiency, field worker productivity, etc. without always remembering that they can (i) lead to shortcuts in client selection and training, field worker training and sensitisation, and loan size determination, (ii) be used as the only criteria for incentive payments to field workers and (iii) put a degree of pressure on them that leaves no time for issues affecting client satisfaction, other than loan turn-around time, and progression in loan size etc.[i]” [ii]
Accordingly, during the Krishna crisis in Andhra Pradesh in 2005/6, the buzz words, post crisis, were ‘code of conduct’, ‘client led micro-finance’ and the like. And many MFIs (backed by the major MFI association) gave assurances (some of them in writing) that would not engage in multiple or over lending, not use coercive recovery methods, not charge usurious interest rates, refrain from breaking up SHGs, reduce consumption lending and the like. They also promised to clean up their governance and various systems/practices - after several systemic issues were highlighted by the Government of Andhra Pradesh then.
Overall, the MFIs said that valuable lessons had been learnt from the Krishna crisis of 2005/6 and they would hereafter practice client led and people oriented micro-finance.
What happened in the ensuing years is now well known and is briefly articulated below:
1. Code of Conduct: Sa-Dhan framed its code of conduct (see attached news item below) and assured the Andhra Pradesh government that it would ensure strict implementation of its code. The code was said to be pro-client and supposedly contained several features to alleviate client problems apparently caused by MFIs. The code of conduct was discussed at the subsequent Sa-Dhan general body meeting and also approved by its members who promised to adhere to it during their operations. I was witness to this event. The government of Andhra Pradesh was apprised of the above and several guarantees (including written assurances) were given by some of the MFIs, involved in the Krishna crisis. That few of the MFIs even gave letters in writing is a fact often mentioned by Dr C S Reddy, CEO of APMAS
2. Banks Were Reluctant to Lend to MFIs After Krishna Crisis of 2005/6: Slowly, things started to get better for micro-finance institutions as the AP Government - on the strength of assurances given by the Micro-Finance industry - let go of its iron handed grip on MFIs and let them function again. However, commercial banks were still not forthcoming to lend to MFIs as some of the private sector banks had lost a significant amount of money during the Krishna crisis. Thus, despite some resolution of the Krishna crisis, the MFIs seemed to be stuck in a situation where they had little resources to finance their increasingly ambitious growth plans, which had not been altogether abandoned and/or altered after the Krishna crisis. Again as the Mr Ghate notes, “One short-term impact of the crisis was a heightened perception of political risk among banks, who both increased interest rates, and reduced new lending to MFIs in AP, especially SHARE and Spandana, in the first few months of the current year.” [iii]
3. Equity[iv] Lends A Helping Hand: This is when social equity investors (including some donors) provided the much needed relief to MFIs - by providing the MFIs with financial resources, they helped MFIs overcome the temporary liquidity problem. Aided by such social equity (investment) pioneers including donors, some MFIs re-started to grow and grow fast. They were rewarded almost concurrently as they received significant equity from other so-called social as well as commercial investors during the same period and thereafter. Please see tables 1, 2 and related figures below
4. Banks Were Back to Financing MFIs: Equity investors had done the trick as post equity investments, the banks started to get back slowly but surely. Thus, progressively MFIs were also able to leverage higher amounts of priority sector bank funds (which in fact almost doubled as compared to each previous year). Led by SIDBI and supported by SBI, HDFC Bank, ICICI Bank, PNB, AXIS Bank and others, DFIs, banks and priority sector loans emerged as one of the biggest funding sources for MFIs. Please do not forget the fact that the biggest additionality of the equity funding was that it helped re-start bank financing to MFIs in a big way, in the aftermath of the Krishna district crisis… Please see tables 3a and 3b and 4a and 4b below
5. The MFI Growth Story Again: With the above resource support, many of the MFIs (especially the large ones) were back to their older ways and they started to experience burgeoning growth from April 2007 to March 2009 - adding the largest number of active borrowers and disbursing the largest amount of loans in global micro-finance history, within a short time span. Therefore, in many ways, these two financial years (April 2007 – March 2009) represent a watershed for Indian micro-finance and I believe that the seeds for the present Andhra Pradesh and Indian micro-finance crisis were actually sown then or thereabouts. That this period of phenomenal growth occurred just 1 to 1 1/2 years after the famous KRISHNA Crisis in Andhra Pradesh (2005/6) is indeed interesting and I think the remarks of Mr C S Reddy, CEO, APMAS (quoted from the CGAP Blog) put the various happenings in proper perspective:
“For almost six years, the MFIs have been asked to improve their practices on the ground. However, there is no improvement. After the 2005-06 crisis, the MFIs came up with the voluntary code of conduct. Its implementation is yet to begin. The SHGs and their federations suffered a great deal due to the exponential growth of the MFIs without any regard for the SHGs.
In 2005-06, MFIs made several commitments like reducing the interest rates, not indulging in multiple lending and that the recovery practices would not be coercive. None of those commitments were acted upon. They did not seem to learn any lessons from the previous experiences. MFIs have pushed a lot of credit resulting in many households in a debt trap.
MFIs have to demonstrate that they “walk the talk”. Those that seem to make comments in support of the MFI practices need to understand the practices on the ground. Responsible microfinance does not exist in practice” - Quoted from CGAP Blog, Crisis or Opportunity.
Please see tables and figures below and annexes 1 and 2 for the data regarding this. The data is sourced from http://www.mixmarket.org/
6. Large % of MFI Assets As Loans Outstanding: These large MFIs and their fast growing newly established professional peers - sensing a great opportunity of attracting more investment and creating wealth alongside the noble cause of enhancing financial access for the world’s poor – started to invest (and deploy) a majority of their new found financial resources as loan assets to micro-finance and other clients. This aspect is reinforced by a recent mix market article which says that in FY 2009, many of these MFIs had deployed almost 90% of their assets as loans to clients – a phenomenally high percentage indeed for any kind of financial institution. As the article notes, “In the aggregate, Indian MFIs have gone from investing roughly 80 percent of their funding into the loan portfolio in 2005 to closer to 90 percent by 2009. This change has also been a driver of growth for the largest Indian MFIs.”[v]
7. Extremely Supportive Policy Environment: The best part is that all of the above happened in the wake an extremely supportive policy environment, which, among other things, called for turbo charging financial access and inclusion. Two mainstream Government of India committees – one on financial inclusion (chaired by Dr Rangarajan) and the other on financial sector reforms (Dr Raghuram Rajan) – made out very strong cases for turbo charging financial access/inclusion efforts and speeding up financial sector reforms to enable the greater/faster inclusion. Meanwhile, the MFIs, in the wake of the above enabling environment and the unfolding India growth story (India was growing at > 7-9%), were able to grow very rapidly and at a scorching pace – even as micro-finance was slowly but surely getting integrated into the mainstream financial sector in India. The fact of the matter is that the growth was caused primarily by the NBFC MFIs and 13 of the top 14 MFIs, ranked in terms of number of clients added between April 2007 – March 2009 were NBFC MFIs, which are supposedly well regulated and supervised. That the regulators and/or supervisors did not feel alarmed by this stupendous and unnatural growth suggests some kind of regulatory/supervisory failure indeed…
8. The Kolar Micro-Finance Crisis of 2009: The Kolar crisis then happened in 2009 and the MFIs had to slow down a bit but MFIN was formed and suddenly a new code of conduct was being discussed and the idea of a credit bureau also took shape. The issues of multiple lending, competition, over indebtedness, aggressive growth, coercive collection etc still remained but they were slowly pushed under the carpet. With the Kolar crisis firmly tackled and no serious lessons learnt, the MFIs started to grow again and many of them received significant equity investments and bank priority sector funding, post Kolar.
9. Run Up to IPO of 2010: All along, through the years, emboldened by their own phenomenal success, some MFIs had started to bring in radical changes in managerial compensation around then - Promoter, CEO and/or senior management compensation at MFIs (including stock options) sky rocketed and micro-finance started to be hailed as the industry of the future (just like IT was about two decades ago). Some of the MFIs, encouraged by some investors (who perhaps wanted a quick exit) and banks who were chasing them as the new messiahs, even readied for an IPO. Meanwhile, some of the MFI promoters/CEOs and senior management cashed-in on their new found wealth rather quietly.
10. The 1st Indian Micro-Finance IPO and Post Listing Aspects: Finally, the market leader MFI was able to secure permission for an IPO despite significant controversies on governance, systems and practices and it experienced great success, tapping almost US $ 360 million to become India’s 1st listed MFI. The shares of the market leader listed at a premium (around Rs 950/share) and they also zoomed after listing to reach an all time high of around Rs 1490 per share. The euphoria was short lived as the market leader dismissed its CEO after a spectacularly successful IPO raising serious doubts about governance in micro-finance and the dirty linen started to be washed in public – with the founder promoter, who came back as executive chairman on one side and the CEO on the other. Legal battle lines were also drawn...The markets always react and they did so in this case, and the publicly traded shares of the market leader MFI started their downward spiral...which is continuing even today…for other reasons…
11. The Suicides in Andhra Pradesh: Meanwhile, around 80 odd client committed suicide and the reasons stated by the government were high levels of indebtedness caused by reckless multiple lending (by MFIs) to shared clients and JLGs, coercive recovery practices, usurious interest and the like – especially, in the wake of increasingly vulnerable livelihood situations caused by various factors including unseasonal rains, NREGA aspects and the like. While is would be unfair and incorrect to link suicides to MFIs loans alone, there is no doubt that MFI practices did indeed contribute significantly to the indebtedness situation on the ground.
12. Micro-Finance as India’s Sub-Prime: In fact the situation prompted ‘Dr Y V Reddy, the former Reserve Bank of India governor - credited with saving the nation’s financial system from the 2008 meltdown – to label microfinance as India’s subprime[vi].’ “Ultimately, its something like subprime lending,” Mr Reddy told Economic Times[vii] in an interview ahead of his book release. “The same incentives are operating here... it was securitisation and derivatives that operated in the US. Here it is the priority sector lending by banks.” “Yes, I agree with Mr Reddy when he says a lot of perverse incentives got aligned,” said Vijay Mahajan, chairman of BASIX, a micro lender, and head of Microfinance Institutions Network. “Here perverse incentives got aligned like in the US and in two years the sector went from helping the poor to preying on the poor.[viii]”
13. The Responses by The AP Government: The Andhra Pradesh government, caught in a very difficult situation, claimed to have no choice but to try and reign in the MFIs; It speedily enacted a hastily put together ordinance, which was not necessarily the most well drafted from a legal perspective but one that sufficient to stem the rot. Post ordinance, the repayments came down considerably and MFIs have also claimed that they are facing a resource (liquidity) crunch. The ordinance has subsequently become a bill.
14. The Malegam Committee Appointed by RBI: Meanwhile the Reserve Bank of India has appointed a Board Sub-Committee in October 2010 to look into the Andhra Pradesh (and Indian) micro-finance crisis while the ministry of finance is said to be readying a special package for MFIs…The Malegam committee is likely to submit its report in Jan 2011 and we all await this historic report…
Before I wind up this rather long but very necessary analysis, I would like to quote the mix market article[ix] which argues that, “three factors appear to have combined to support the growth of Indian microfinance:
· Rapid increases in equity investment...
· ...in an environment with easily available commercial financing...
· ...and increasing investment by MFIs into the loan portfolio
None of these factors are sufficient to explain growth in isolation – many other sectors have rapid growth of equity or commercial financing, but without the level of growth seen in India. A focus solely on equity investment ignores the far-larger pool of funds provided by priority-sector lending or the changes in MFI portfolio management. Together these factors create a ‘perfect storm’ to grow loan portfolios rapidly and are thus under the microscope for the current crisis.”
Thus, while it is now an accepted fact that MFIs grew at a scorching unbelievable pace and perhaps did not engage in RESPONSIBLE Micro-Finance as promised by themselves, without question, we need to understand the happenings better in terms of motivations. In my opinion, the happenings and data indicate four major drivers for this unprecedented growth and they are given below:
- MFIs Grew Rapidly Because They Wanted Greater Investment and Better Valuation and Were Keen to Tap Capital Markets And Create Wealth For All Concerned
- The Financial Inclusion Drive by Policy, Donors and International Agencies Also Resulted in MFIs Growing At A Scorching Pace
- The Commercial Banks Pushed MFIs To Grow At A Burgeoning Rate So That They (The Banks) Could Achieve The Mandatory Priority Sector Lending Targets Which In Turn Was in Some Sense Driven by the Policy Initiatives
- Investors Who Paid a Huge Premium Sought Commensurate Returns ASAP And They Caused MFIs to Grow Very Rapidly
While the above are possible explanations, they need to be better explored and this has to be properly researched and understood by The RBI Board Sub-Committee – as only then can proper remedies, to cure the actual causes, be offered. Otherwise, the solutions provided may tackle just the symptom whereas the disease could still be spreading… I sincerely hope that the RBI Board Sub-Committee, looking into the micro-finance, calls for authoritative (emphasized as reliable/valid) data[x] on the above and analyses the same before outlining its prescriptions for regulation of the Indian micro-finance industry…This is a crucial step that will enable the RBI to take greater charge of the ‘orphaned’ Indian micro-finance industry that is desperately and urgently seeking a legitimate regulator…
[i] Footnote in the State of the Sector Report: Ironically, Spandana was widely lauded by the MFI community for being a highly profitable MFI, and for having unusually high efficiency with extremely low operational costs. It was not clear to most observers at the time that these were being minimised at the expense of repercussions on client
satisfaction. On the other hand Spandana's profitability had attracted adverse political attention well
before the crisis, in response to which Spandana had indeed started reducing interest rates.
[ii] Source: Microfinance in India: A State of the Sector Report, 2006 by Prabhu Ghate
[iii] Source: Microfinance in India: A State of the Sector Report, 2006 by Prabhu Ghate
[iv] My usual caveats apply with regard to the data.
[x] While the above are all serious possibilities, the lack of reliable and valid data prevents us from making a conclusive argument. For example, I have been struggling, despite my deep-rooted contacts in the Indian micro-finance industry to get reliable data on how bank lending to the micro-finance industry in India grew in the same period. Likewise, it has also been extremely difficult to get accurate information on the various equity deals that happened in Indian micro-finance during the last few years. I am close to finishing this and will post separately on the same, as and when credible data becomes fully available